Saint Nick’s cheer and timely toy deliveries have brought families of all kinds together for generations.
Included in the benefit of Santa’s joy is the large, global investing family that enjoys a strictly-scheduled, year-end rally called the "Santa Claus Rally", so long as they make the “Nice” list.
The Santa Claus Rally is a year-end phenomenon in which the stock market typically rises in the six trading sessions after Christmas. This means that the rally occurs during the first four trading sessions following Christmas Day and extends into the first two trading sessions of the following year. That means that for 2020, the rally is slated to last from December 28 through January 4.
Naughty or Nice
The fact that the Santa Claus Rally exists as a phenomenon implies that investors make the Nice list more-often-than-not. In fact, the rally happened during 17 of the last 26 years or about 65% of the time. Since 1950, the S&P has averaged 1.3% gains during this period of time with the largest gain of last decade coming in 2018 at 4.1%.
Despite usually making the Nice list, investors have woken up to a fair share of coal in their stockings and have even endured bad streaks where the returns just weren’t coming. From 1999 through 2007, the Santa Claus Rally turned rout, averaging negative results on account of failing to rally in 1999, 2004, and 2007.
The consistency of the rally over many decades affirms that the rally is an ongoing phenomenon. Regardless of its presence in the market, nobody knows exactly how or why this phenomenon occurs, though there are many theories.
Scrooge’s Theories
While Christmas magic may be a viable answer to the phenomenon to some, there are many out there that seek a more tangible answer to the rally than accrediting it to the centuries old gift-giver. This includes tax strategies, changing of the months, and low-volume trading sessions.
Home Alone
One of the leading theories for why this happens is because the last week of December is notorious for its low-volume. This period of time typically has the lowest trading volume of the year. This is because institutional investors, who usually dominate volume and tend to trade conservatively, are often on vacation during this week. This leaves trading for these days in the hands of the bullish retail investors who, in turn, decide to make it rally.
Rallies: Turn-of-the-Year-Edition
Another potential reason for the post-Christmas rally is that it is actually a special case of the so-called “Turn-of-Month Effect.” The Turn-of-Month Effect is the tendency of stocks to experience higher returns during the days ending and beginning a month. In the last four trading days of a month, and the first two of the following months, stocks rise 64% of the time, just 1% less than the 65% mark set by the Santa Claus Rally. The theory here is that the Santa Claus Rally is, in fact, just the year-ending version of the Turn-of-Month Effect.
The Early Birds
The January Effect is another phenomenon that could be intertwined with the Santa Claus Rally. The January Effect is the tendency of the stock market to rise in January, following a fall in December. This occurs as investors sell-off losing stocks in order to offset some of their realized capital gains to minimize capital gains taxes. This primarily affects small-cap stocks.
Because of this, one of the drivers of the Santa Clause Rally could in fact be investors purchasing stocks at a late, low-point late in December to beat other investors to the January Effect and maximize their returns during the next month.
This year
For this year it is too early to tell which list we will make, though history suggests a place on the Naughty list may be in order. This is because of the record rally that was experienced during the month of November that saw the S&P 500 gain 11.2%. Historical data suggests that the Christmas rally is missed when November gains exceed 5%, as investors cash out on those gains early.
